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REIT SKN's CEO is evaluating how much to pay for an income producing property. He intends to finance this acquisition with the same ratio of
REIT SKN's CEO is evaluating how much to pay for an income producing property. He intends to finance this acquisition with the same ratio of debt and equity as is presently being used to fund REIT SKN. He surveys the investor and broker communities to assess the expected return from similar investments and is informed that the opportunity cost of capital (OCC) should be 12.0%. However, Sam's senior investment advisor believes that there may be some environmental issues with this property which are not being fully captured in the OCC. The additional compensation associated with cleaning the property of environmental issues would amount to an additional 3.0%. Also, based on the evaluation of the existing portfolio of properties presently owned by REIT SKN, its present weighted average cost of capital WACC) is 11.0%. Sam concludes that if he would acquire the new property REIT SKN's WACC would increase by 4.5% to 15.5%. Finally, as a matter of policy established by Sam, REIT SKN would not undertake any investment unless it can reasonably underwrite the investment at an expected return of 14.0%.
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